Greenwich: Fixed Income Investors Grapple with New Regulations and Rising Rates

Each year Greenwich conducts a North American Fixed Income study. This year we conducting 1027 interviews of buy side portfolio managers and traders about everything from corporate bonds to agency pass-throughs to interest rate swaps. As I’m new to Greenwich this is my first time really digging into the results, and (although I’m now a bit biased) they’re fascinating. The large sample set makes it possible to look narrowly at various subsets for trend (think hedge funds with less than $5 billion under management trading CMBS, for example). The below press release highlights a small set of the findings. In the next few weeks I’ll be a releasing another report based largely on this data examining liquidity in the credit market. Not just the corporate bond story we all know so well, but the impact of e-trading in swaps and other market structure trends.

Stamford, CT USA —U.S. fixed-income investors rank new regulations as one of their top concerns for the coming year, along with rising interest rates and diminished market liquidity, according to a new study, U.S. Fixed-Income Market Forecast: Cloud with Silver Linings, from Greenwich Associates.

As institutional fixed-income investors attempt to protect returns amidst rising interest rates, they are still struggling to assess the impact of new derivatives rules. Eighty percent of the more than 1,000 portfolio managers and traders taking part in the annual Greenwich Associates 2013 U.S. Fixed-Income Investors Study include regulations among their top priorities. One reason for this concern: Many institutional investors interviewed left preparations for central clearing until the last minute, forcing them to accept unfavorable terms from clearing brokers simply to gain access to needed clearing services.

Among the main risks facing investors amid the switch to central clearing are short-term disruptions during the transition period and potentially higher fees and margin costs for some buy-side firms. Central clearing will also bring benefits, including a simplified trading process and the potential for increased competition as new sell-side participants are attracted to the market.

“Because most of these firms only made this transition a few months ago, they are in no position to assess the actual long-term impact of central clearing on their businesses, and they see it as a big, looming risk,” says Greenwich Associates consultant James Borger.

SEFs Will Alter Relationships Between Investors and Dealers

While the transition to central clearing might be disruptive for investors in the short-term, it will not fundamentally change the way buy-side and sell-side trading desks do business – swap execution facilities (SEFs) will.

Trading via SEFs will be a less personal experience. While voice trading will still be permitted in some cases, the vast majority of trading in mandated products will occur on the screen. Request for quote platforms will provide the buy-side with some choice in counterparty as will the block trade exemption, but the chips are stacked against current methods for keeping buy-side/sell-side relationships alive.

These changes will continue the current trend of buy-side investors looking to a larger number of sell-side dealers for liquidity. The average number of dealers used by U.S. fixed-income investors has increased from roughly seven in 2009 to nearly 10 in 2013. This trend will only continue as more trading occurs on screen and more trades are cleared removing counterparty credit concerns. Study results indicate that despite expectations that the buy-side would execute and clear their trades in one place, only 22% of U.S. institutions expect to increase trading volume allocated to their clearing brokers.

Although these changes are dramatic, they come with a silver lining: “Mandatory SEF trading will fundamentally change the way buy-side swap traders interact with the dealer community, the ultimate result will be a positive one, especially for smaller and mid-sized asset managers,” says Kevin McPartland Greenwich Associates principal, market structure and technology advisory service. “They will benefit from tighter spreads and access to more liquidity providers than were available to them in the OTC market.”